Played 'Catch & Release' with a 'Falling Knife'

Last December 18th contract manufacturer Jabil Circuits (NYSE:JBL) was a very hated name. Management preannounced expectations for a bad fiscal 2014 (ends Aug. 31, 2014). The stock gapped down, completiong its plunge from a September 2013, peak of $24.32 to just $15.30.

JBL was the proverbial ‘falling knife’ that traders are told to avoid trying to catch. Nobody knew where the drop would end but history said it was probably close to bottoming. JBL’s calender 2011 low, set during the European banking crisis market panic, was $13.90. Its 2012 nadir came at $16.80.

I sprung into action by selling 14 contracts of JBL’s Jan. 2015, $15 puts @ $1.90 per share. That lowered my ‘if put’ price to just $13.10, a level that had not been seen since 2010. I also sold 6 contracts of JBL’s Jan. 2015, $17 puts @ $3.02 per share. The ‘if exercised’ break-even price on that more aggressive strike was set just a shade higher, at $13.98.

Those naked put option sales committed me to buy 2,000 shares of JBL, if exercised, at what I deemed to be a very attractive net entry price.

The trade required tying up some buying power, but required no actual cash outlay, as I sold the puts in a margin-type account against paid-up equity that was already held at that brokerage firm. My account was credited with $4,451 in cash from the sale of those 20 contracts.

Twelve days later, JBL had rebounded to above $17. I felt confident that I’d seen the low. On New Year’s Eve I sold some longer-term and slightly more aggressive JBL Jan. 2016, $18 puts @ $3.90 per share. Break-even on this later JBL put sale was $14.10.

As advertised, the company’s February quarter EPS came in pretty weak, at 3-cents versus a year-earlier 44-cent profit. Fiscal Q3 results were released after the close on June 18th. A six-cent per share loss was 10-cents better than the already lowered expectations. Guidance for a much better year in FY 2015 was enough to catapult the shares higher today. JBL closed on June 19th at $20.63.

That was a large enough improvement to allow me to close out my 2015 expiration options seven months early while capturing the lions’ share of the potential gains.

Here is what the quotes looked like at 3:16 PM this afternoon, with the stock trading at $20.45.

I paid 30-cents per share to close out the $15 strikes and 55-cents for the $17 series. My obligation to buy 2,000 shares of JBL is now permanently removed.

My real money trades are documented above. The net profit of $3,681 represents 82.7% of the maximum possible gain, of $4,451, had I seen both sets of options expire worthless after waiting seven more months until expiration. Note that all numbers include commission expenses.

Naked put writing is widely misunderstood. My worst case scenario was less risky than outright purchase of 2,000 JBL shares on the trade inception date. Simply buying JBL would have required a cash outlay of about $31,000. Instead, my account brought money in the door.

My return on investment was infinite/incalculable. I never had a net cash outlay from start to finish. I received $4,451 initially and gave back $770 of that amount when I bought to close, extinguishing my obligations.

There are further, unrealized, gains on the 2016 puts which are still in play. With option transactions you should never count your chickens before they are hatched. I will not tally any results from that set of options until they expire or I have closed them out.

The extra margin of safety provided by put premiums generally allows for gains if the underlying stock:

Moves up

Remains unchanged

Declines slightly

That covers a wide band of potential price movements, making option writers' ultimate success a high probability result.

Conservative use of option sales can be a great adjunct to basic value investing. This was just one position that netted a nice sum over a six-month period. Selling dozens of similar put positions, if your account size permits, can create a significant income stream that typically leads to substantial capital gains over time.

I have been successfully selling options for more than 35 years. View all the closed-out and present option positions in my Market Shadows Virtual Put Writing Portfolio by clicking here.

You'll need to scroll all the way down the page to see the full list of close-outs along with the profit and loss on every completed trade since our Jan. 2013, portfolio inception date.

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